Credit-rating downgrades often feel like sudden shocks to companies, lenders, suppliers, and investors. However, in most cases they are the end result of problems that have been building up over time. For companies operating in India, it’s essential to understand the typical triggers of downgrades — so that one can anticipate, mitigate and communicate effectively before the rating committee acts.
This article explains the major causes of credit rating downgrades in India, how rating agencies evaluate these issues, real-life patterns seen in recent downgrade rationales, and what companies should do to prevent or respond to such situations.
Key causes of downgrades
1. Liquidity deterioration and working-capital stress
One of the most frequent reasons why ratings are cut is weakening liquidity: e.g., rising debtor days, over-utilised bank limits, fall in free cash, and use of short-term borrowings to fund long-term needs. Rating agencies consistently highlight these in downgrade rationales.
For example, a recent case cites a debtor-days number of 166 days and full utilisation of working-capital lines as a cause of a rapid downgrade. (Hemindra Hazari)
Why it matters: Liquidity stress means a company may struggle to pay interest or principal when they fall due — which directly raises default risk in the eyes of agencies.
2. Rising leverage and weakening coverage metrics
As companies borrow more (or replace equity with debt) and earnings don’t keep pace, several financial-ratios begin to deteriorate — e.g., total debt/OPBDITA, interest-coverage ratio, debt/EBITDA. Rating frameworks typically have thresholds for such ratios; sustained breaches often trigger downgrades. (Tickertape)
Why it matters: Higher leverage reduces financial flexibility and magnifies the impact of any shock (e.g., margin drop, working capital slip). Lenders and rating agencies see this as higher risk.
3. Declining profitability and cash-flow generation
When margins shrink (due to input costs, pricing pressure or volume decline) or when cash flow from operations turns negative, that signals weaker ability to service debt and fund operations. Rating agencies frequently cite margin erosion plus leverage creep in downgrade commentary. (Tickertape)
Why it matters: Profitability is a buffer for debt servicing and unexpected shocks. Weak profitability means less buffer and less room for manoeuvre.
4. Asset-quality / Receivables stress and rising non-performing assets (NPAs)
For companies where a large portion of assets is in receivables (or loans in case of financial institutions), deterioration in asset quality — increasing write-offs, higher provisioning, rising ageing of receivables — becomes a material threat to creditworthiness. Although many rationales focus on corporates rather than banks in India, the same principle holds: worsening collections → weaker cash flows → higher risk of default. (Hemindra Hazari)
Why it matters: Asset-quality stress often means unexpected losses, capital erosion, and higher funding costs. It also undermines the confidence of banks and investors.
5. Sectoral or macroeconomic shocks
A company may be fundamentally sound, but if the sector in which it operates is under strain (due to demand collapse, regulatory change, input cost surge, commodity price swing), then the risk profile goes up. Rating agencies embed industry/sector outlook into their ratings. For example, a severe or prolonged sectoral downturn may trigger a cascade of downgrades. (India Budget)
Why it matters: Sectoral problems affect many companies simultaneously, limiting refinancing options, shrinking buyer markets, and reducing bargaining power — all of which increase the risk of default.
6. Governance issues, related-party transactions, and management concerns
Credit ratings do not only reflect numbers; the “Q” side (qualitative) matters a lot. Weak governance, opaque related-party transactions, frequent management changes, delayed disclosures, or non-cooperation with rating agencies raise uncertainty. Agencies penalise this uncertainty because it reduces predictability. For example, non-cooperation itself is a stated cause of ratings being downgraded or shifted to “Issuer Not Cooperating”. (Tickertape)
Why it matters: Governance failures increase the risk of unexpected adverse events (fraud, litigation, regulatory sanctions), making the firm riskier in the eyes of lenders and investors.
7. Execution/funding liquidity events or one-off adverse events
Large one-off events may also trigger downgrades: project delays, cost overruns, order cancellations, regulatory penalties, litigation losses, loss of a major customer, or sudden withdrawal of funding. Even a company with generally sound metrics may find itself downgraded if such an event impairs cash flows materially. (Hemindra Hazari)
Why it matters: These events reduce future cash flows and/or increase outflows, which raise default risk. Rating agencies treat them seriously because they are often the catalysts that transform a latent problem into a crisis.
How rating agencies weigh these factors
Rating agencies follow a structured methodology: they combine quantitative thresholds (leverage, coverage, liquidity, asset-quality) with qualitative assessments (management quality, governance, transparency, sector outlook). A single extreme breach (e.g., liquidity collapse) or accumulation of moderate weaknesses across several pillars usually triggers a downgrade. (Tickertape)
Moreover, agencies look at the ability of the borrower to access alternate funding sources (diversity of lenders/investors), group/parent support (if applicable), and the transparency of disclosures and responsiveness of management.
In practice, many downgrade rationales cite several of the above factors occurring simultaneously (for example: rising debtor days + full bank lines + cost‐overrun + governance concerns) rather than just one.
Recent patterns seen in Indian market
- Liquidity-led downgrades: Several firms report lengthening receivables and full utilisation of working-capital lines; agencies cite “stretched debtor days”, “fully utilised bank limits”, “negative cash from operations” as immediate triggers. (Hemindra Hazari)
- Metric‐threshold downgrades: Companies whose debt/OPBDITA or interest-coverage ratios breach rating model thresholds for two or more consecutive periods often get downgraded. (Tickertape)
- Non-cooperation or information delays: When companies delay filing disclosures, or rating agencies cannot get regular updates, ratings are either downgraded or moved to ‘non-cooperating’ status. The lack of transparency itself raises risk. (Tickertape)
Consequences of a downgrade (what happens next)
A downgrade isn’t just a letter-grade change. It has real implications:
- Higher borrowing costs: Lenders price in higher risk, leading to higher interest rates or reduced tenors.
- Tighter covenants or accelerated repayments: Some debt contracts include triggers tied to ratings. A downgrade may cause margin increases or require early repayment.
- Reduced working-capital availability: Suppliers may shorten credit terms; borrowers may find bank lines reduced or costlier.
- Reduced investor confidence: For companies issuing debt or seeking public equity, a downgrade can reduce appetite and increase cost of capital.
- Contracting opportunity: For firms bidding for government contracts or tenders, a weaker rating may exclude them if rating minimums are specified.
What companies can do to prevent or respond to downgrades
Preventive measures
- Monitor liquidity proactively: Track bank‐limit utilisation, debtor maturities, free‐cash position, short-term borrowing levels. Set early-warning triggers.
- Align debt maturity with asset life: Avoid funding long‐term projects with short-term borrowings. Choose debt tenure suited to the underlying investment.
- Maintain healthy profitability: Focus on margin improvement, cost control, efficient operations, and realistic pricing.
- Manage working capital tightly: Shorten debtor days, negotiate better supplier terms, avoid excessive inventory build-up, monitor receivable ageing.
- Strengthen governance and transparency: Timely disclosures, independent audit, clear related-party reporting, robust board oversight.
- Engage rating agency early: If stress is anticipated, communicate with the rating agency, share remedial plans and cash-flow projections — cooperation reduces uncertainty of outlook revision.
Immediate actions after a downgrade
- Engage with lenders and major suppliers: Provide a clear plan of action, explain prospects and funding strategy.
- Revisit covenant terms proactively: Seek waivers or restructuring of terms before default triggers.
- Prioritise cash flows: Focus on servicing critical obligations, restructure shorter debts, delay non-essential capex.
- Use the rating‐report as a roadmap: Study the agency’s downgrade rationale, identify the weak pillars, and embed corrective actions into strategy.
Final thought
Credit-rating downgrades are rarely surprises for well-governed, well-monitored companies — they are usually the result of known issues that were not addressed in time. The best defence is early detection, transparent communication, disciplined cash-flow management and readiness to engage proactively with lenders, investors and rating agencies.
When management treat rating feedback as a roadmap rather than a verdict, they reduce the odds of a downgrade and increase the chance of recovery or upgrade over time.
About Us
At FinMen Advisors, we specialise in Credit Rating Advisory and help companies understand rating-drivers, prepare for evaluations, remediate pre-rating weaknesses and engage confidently with agencies. If your company is facing early warning signals or has recently been downgraded, we offer a structured diagnostic and remediation roadmap to stabilise liquidity, improve coverage, strengthen governance and rebuild rating momentum. (Analytical advisory only; no guarantees or assurances of rating outcomes.)
